There are additional factors to take into account when evaluating the viability of commercial real estate investment versus residential. On top of the usual considerations, commercial property investors need to explore the macroeconomic elements that will impact the success of their investment and the industry it operates in.
With this in mind, have you ever wondered how to evaluate a commercial real estate investment?
In this article, we will cover:
What is commercial real estate?
Let’s start simple. Commercial real estate comes in different forms – from agricultural facilities, retail stores, to office buildings and hospitality venues.
Commercial real estate is property used to operate a business. The Australian commercial real estate industry holds a large footprint. According to CoreLogic’s latest data, commercial real estate makes up $1 trillion of Australia’s wealth.
How to evaluate a commercial real estate investment
Evaluating any type of investment property will include carrying out due dilligence which essentially means crunching the numbers. This includes factors like rental income and yield, demand vs supply, financing requirements, how the purchase will impact your cash flow and much more.
These are all extremely relevant when evaluating a commercial real estate investment. You will also need to think outside the box and evaluate factors that will impact the success of the property.
If you’re looking to purchase a commercial real estate investment, we have broken down these factors to five parts.
1. Know the property’s history
If the property is already established and has been used as an investment in previous years, you’re fortunate to have plenty of information and data points.
Go through the property’s history and determine how it performed for the previous owners. Some of this information will be confidential but a good indicator is the percentage of time the property was tenanted. This is important to know in the early stages as the higher the percentage the more likely it is to be a solid investment choice.
2. Research the current property market throughout your evaluation
What is the commercial property market doing in the area you are looking to buy? The market can be volatile, and while you’re not expected to predict the future, a baseline knowledge is still essential.
This means conducting activities like a year-on-year market analysis, evaluating the increase or decrease of rental rates, looking into overall market trends and projected growth in the industry. You can really drill down in this analysis and note things like if there is a new commercial estate opening up nearby that may take prospective tenants wanting new facilities.
3. Track industry trends
Unlike residential property, commercial property is significantly differentiated throughout the industry it operates within. In addition to the property market in general, you need to know this industry like the back of your hand. The industry demand is a determining factor of attracting tenants.
For example, the warehouse industry is currently in high demand and it looks like it is just getting bigger with consumer preferences moving online. Recent forecasts have suggested that online sales will grow by $12.8 billion in 2021, which would result in a demand of about one million square metres of warehouse demand due to e-commerce activities alone. Data points such as this are a good reference when evaluating a commercial investment.
4. Identify the tenant market and weigh up with supply vs demand
How niche or broad is the property’s tenant market? An office space or hospitality venue are examples of properties that would have a broad tenant market. While a poultry farming facility or medical practice are examples of properties with niche tenant markets.
Should you be targeting a broad or niche tenant market? The answer to this isn’t straight forward. What you should be evaluating is how the tenant market’s demand weighs up against property supply.
Holding a property that’s in high-demand and not in an over-saturated market should be the goal. Anything else can impact the property’s success and how much power you may have in lease negotiations.
5. Estimating the likely depreciation available
Property depreciation is the natural wear and tear of a property and its assets over time. You don’t need to spend any money to claim depreciation, so it’s the only ‘non-cash’ deduction available from the property.
Depreciation can often be the difference between a positive and negative cash flow. Therefore, it’s essential to include it as part of your initial evaluation of the property.
BMT Tax Deprecation is here to help with your commercial real estate evaluation. The team can provide obligation-free preliminary estimates on all types of commercial properties. To learn more, visit BMT’s commercial page or Request a Quote.